Economy 24 August 2020, 5:20pm

Hungary cenbank caught in crossfire: Has inflation really made it more cautious?

Portfolio

The Monetary Council of the National Bank of Hungary (MNB) could apply a lot more cautious stance at its upcoming policy meeting on Tuesday due to a much higher than expected inflation in July. Analysts polled by Portfolio do not expect monetary conditions to be changed, but investors should keep a close eye on the MPC's official statement.

Interest rate could be frozen

After two consecutive rate reductions, the central bank base rate is likely to remain on hold for a long time. Analysts polled by Portfolio all think it will remain unchanged on Tuesday at 0.6%. Better yet, they do not project a change until the end of 2021. Gergely Suppan, analyst at Takarékbank thinks there will be a 5-basis-point raise to the interest rate corridor.

Nevertheless, we had not one but two pieces of news in the last few weeks that could warrant changing rates:

Firstly, inflation unexpectedly surged in July to 3.8% yr/yr from 2.9% in June. The new print is extremely close to the upper end of the central bank's tolerance range, which would warrant cautioun from the MNB's part. Consequently, analysts think that there is no chance for further rate cuts. Quite the contrary, if inflation pressure keeps on mounting monetary tightening could becomes a realistic scenario in the longer term.
A move in the opposite direction would be justified by the fact that Hungary's GDP contracted by more than expected (13.6% yr/yr) in the second quarter of 2020. This foreshadows a deeper annual recession than previously thought therefore the MNB could feel the economy needs greater stimulus so it should ease interest rate conditions further.

As a result of the above, the MNB could feel it is between a rock and a hard place. On the one hand, it should further stimulate economic growth. On the other hand, cutting rates further could be risky for the forint. And if the HUF starts to depreciate abruptly it will fuel inflation further, while CPI is already dangerously close to the upper end of the tolerance range (3.0% +/-1ppt).

When should we expect the first move by the MNB?

The central bank's first reaction to the above dilemma could be that it applies a wait-and-see attitude to see how lasting inflation pressure will be and how fast the economy could rebound after hitting rock bottom. Additionally, the next quarterly Report on Inflation is due out in late September and leaning on that document the MPC could take a bigger step then should it want to.

the only change we should see this time is a more hawkish tone than in july in the mpc's official statement.

Although inflationary developments have made the sustainability of loose monetary conditions questionable, I think the MNB will hold out in August and will choose to wait for the Inflation Report before making a move, commented Gábor Regős, economist at economic researcher Századvég. In his view, the most the MNB will do this month is stressing that it closely monitors inflationary processes, but the market will not interpret this as a meaningful tightening.

Looking forward and on the basis of currently available information and data, Hungary's headline inflation could reach the upper end (4.0%) of the central bank's tolerance tange by the end of Q3 2020 (given the base effects), and then it could possibly breach this threshold in Q4. After that, however, in the longer term it is unlikely that inflation will go north of 4.0% in respect of its quarterly course, said Ákos Kuti, analyst at MKB Bank.

After a forint strengthening in July, it could have been raised as a possibility that the MNB would not stop the reduction of the base rate at 0.6%, but in view of the latest CPI data the probability of further easing has decreased significantly, commented Orsolya Nyeste, analyst at Erste Bank. A maginflációs adatok emelkedése arra utalhat, hogy nemcsak egyszeri hatások állnak a magasabb infláció mögött, hanem a „mögöttes folyamatok” is a korábban vártnál magasabb inflációs pályát sugallnak.

Although the supportive base effect could lead to a marked deceleration of inflation from the fourth quarter onward, the overall picture continues to show that GDP contraction has not brought about the expected disinflationary effects in the Hungarian economy. Consequently, the MNB is likely to stick to its previous rhetoric, saying it continues to deem the current interest rate level as adequate and that it plans to make sure short interest rates remain steadily north of zero. Economist at Erste, however, do not project a rate hike despite the surge in inflation, stressing that uncertainties in respect of economic recovery remain significant.

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